Tilt the playing field of the world economy

I have a six-year-old son. His name is Jin-Gyu. He lives off me, yet he is quite capable of making a living. After all, millions of children of his age already have jobs in poor countries.

Jin-Gyu needs to be exposed to competition if he is to become a more productive person. Thinking about it, the more competition he is exposed to and the sooner this is done, the better it is for his future development. I should make him quit school and get a job.

I can hear you say I must be mad. Myopic. Cruel. If I drive Jin-Gyu into the labour market now, you point out, he may become a savvy shoeshine boy or a prosperous street hawker, but he will never become a brain surgeon or a nuclear physicist. You argue that, even from a purely materialistic viewpoint, I would be wiser to invest in his education and share the returns later than gloat over the money I save by not sending him to school.

Yet this absurd line of argument is in essence how free-trade economists justify rapid, large-scale trade liberalisation in developing countries. They claim that developing country producers need to be exposed to maximum competition, so that they have maximum incentive to raise productivity. The earlier the exposure, the argument goes, the better it is for economic development.

However, just as children need to be nurtured before they can compete in high-productivity jobs, industries in developing countries should be sheltered from superior foreign producers before they “grow up”. They need to be given protection, subsidies, and other assistance while they master advanced technologies and build effective organisations.

This argument is known as the infant industry argument. What is little known is that it was first theorised by none other than the first finance minister (treasury secretary) of the USA - Alexander Hamilton, whose portrait now adorns the $US10 bill.

Initially few Americans were convinced by Hamilton’s argument. After all, Adam Smith, the father of economics, had already advised Americans against artificially developing manufacturing industries. However, over time people saw sense in Hamilton’s argument and the US shifted to protectionism after the Anglo-American War (1812-6). By the 1830s, its industrial tariff rate, at 40-50 per cent, was the highest in the world and remained so until World War II.

The US may have invented the theory of infant industry protection, but the practice had existed long before . The first big success story was, surprisingly, Britain - the supposed birthplace of free trade. In fact, Hamilton’s program was in many ways a copy of Robert Walpole’s enormously successful 1721 industrial development program, based on high (among world’s highest) tariffs and subsidies, that had propelled Britain into its economic supremacy.

Britain and the US may have been the most ardent - and most successful - users of tariffs, but most of today’s rich countries deployed tariff protection for extended periods in order to promote their infant industries.

Many of them also actively used government subsidies and public enterprises to promote new industries. Japan and many European countries have given numerous subsidies to strategic industries. The US has publicly financed the highest share of research and development in the world. Singapore, despite its free-market image, has one of the largest public enterprise sectors in the world, producing about 30 per cent of the national income. Public enterprises were also crucial in France, Finland, Austria, Norway, and Taiwan.

When they needed to protect their nascent producers, most of today’s rich countries restricted foreign investment. In the 19th century, the US strictly regulated foreign investment in banking, shipping, mining, and logging. Japan and Korea severely restricted foreign investment in manufacturing. Between the 1930s and the 1980s, Finland officially classified all firms with more than 20 per cent foreign ownership as “dangerous enterprises”.

While (exceptionally) practising free trade, the Netherlands and Switzerland refused to protect patents until the early 20th century. In the 19th century, most countries, including Britain, France, and the US, explicitly allowed patenting of imported inventions. The US refused to protect foreigners’ copyrights until 1891. Germany mass-produced counterfeit “made in England” goods in the 19th century.